How Much Life Insurance Do You Need?

From Rick Kahler

Life insurance is an important financial planning resource. However, it is not meant as a source of income. Its primary purpose is to provide the means to replace income or to pay taxes or debts.

Not everyone needs life insurance. Once you determine that you do, the next big question is how much is appropriate.

Here is one way to help answer that question. It is not a formula, but a very rough checklist to help you estimate your individual insurance needs. For couples, I suggest separate lists. Not all of the information will be the same for each spouse.

First, list the following:

1. All debt (mortgage, credit cards, car loans, student loans, etc.).
2. Anticipated kids’ college education needs (if in doubt, use $120,000 per child).
3. Estimated annual living expenses, multiplied by 1.33 and multiplied again by the number of years from now until the youngest child graduates from college.
4. Estimates for large one-time future expenses for which there is no savings (car purchases, weddings, major home repairs or updates, relocation expenses, educational costs for surviving spouse).
5. The annual amount of maximum contributions allowed to all retirement plans (if in doubt use $64,000). Multiply the total by the difference between age 70 and your current age. For couples, figure each spouse’s total separately.

Item five is something people often don’t think of as a need that life insurance might cover. It is especially important to consider this for anyone within a decade or so of retirement age. Suppose you are widowed at age 55. Losing your spouse’s earnings would affect your immediate income. In addition, losing the contributions your spouse would have made to retirement accounts could severely reduce your retirement income. The impact could be especially significant if the surviving spouse is not employed or earns much less than the deceased spouse.

Total items one through five. The amount will probably be large enough to scare you, but don’t panic.

Now, make a second list:

1. The estimated annual income that would continue after one spouse’s death (from real estate or business investments, partnerships, the surviving spouse’s earnings, etc.), multiplied by the same number of years as in number three above.
2. The estimated annual income that would start upon one spouse’s death (Social Security Survivors Benefits, pension income, Worker’s Compensation, etc.), multiplied by the same number of years.
3. The estimated total of any liquid assets (like securities or mutual funds) that would be held at the time of one spouse’s death
4. Insurance proceeds from other policies.

Add these together, then subtract the total from the total of the first list. The result should give you an idea of how much life insurance would be appropriate for you.

This amount may still seem overwhelmingly large, especially for parents of young children. The answer, in most cases, is term life insurance.

Here are two examples, taken from a March 2017 NerdWallet article by Barbara Marquand, comparing term and whole life insurance.
1. A 30-year-old man could buy a $1 million 30-year term policy for $720 a year. The same amount of whole life insurance would cost him $9,217 a year. By the time the term policy expired at age 60, he should no longer need that much coverage.
2. A 50-year-old woman could cover her retirement plan contributions with a $500,000 20-year term policy. Her premiums would be $898 a year, compared to $10,802 for whole life insurance.

Using this checklist can help you make sure you are adequately insured, and that you do not waste money on insurance that isn’t right for your needs.